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Growth and Inequality

In the wee hours of last Thursday morning, the House passed the Central American Free Trade Agreement (CAFTA), lowering trade barriers between the United States and six small Latin American countries by a two-vote margin (or a one-vote margin if Republican Representative Charles Taylor’s vote had been counted).  The next day, the Commerce Department released figures indicating that the economy grew at a healthy 3.4% in the second quarter of the year.  These two separate, seemingly positive events actually demonstrate the gloomy structural change undergone by the U.S. economy over the past 50 years.

On the surface, freer trade between nations and an increase in Gross Domestic Product (GDP) are decidedly excellent developments for the United States.  Yet, when one goes behind the numbers, a drastically different picture comes into focus.

From an economic viewpoint, free trade is overwhelmingly good.  It creates greater competition as more companies work to serve the same market.  It forces firms to lower prices, innovate, and become more efficient, which leads to specialization, where companies focus on the specific tasks they do best.  David Ricardo articulated this principle through his theory of comparative advantage, which states that if Guatemala can produce nails cheaper and better than Nicaragua, and Nicaragua can produce cutting boards cheaper and better than Guatemala, then Guatemala should produce nails, Nicaragua should produce cutting boards, the countries should trade, and then both will be better off.

States often protect politically powerful industries from outside competition through subsidies, tariffs, and quotas, and the U.S. is no exception.  For example, US consumers have paid twice the world price of sugar for the past 75 years thanks to protectionist measures successfully secured by the sugar industry.  Though $0.24 a pound compared to $0.12 a pound may not seem like much, it quickly adds up –at both the checkout line and for the sugar industry’s bottom line.  CAFTA would actually begin to chip away at this inequitable situation, but the issue with CAFTA is not world sugar prices but instead world labor wages, environmental standards, and workplace safety regulations.

The reason that many developing countries can produce goods more cheaply than the United States is quite simply labor and regulation costs.  The labor market in countries from El Salvador to Honduras is much looser than in developed countries.  In addition, the dollar’s purchasing power is much greater.  Therefore, multinational companies can pay workers comparatively much less than in developed countries and workers will accept this wage because it is comparatively better than anything they were receiving before. 

The cost of business is also much cheaper in developing countries.  There are not as many stringent regulations related to the environment and workplace safety.  Companies can pollute much more in the Dominican Republic and not be accountable for it, while in the U.S. they would be required to clean up their mess (at least to an extent).  Firms also do not need to worry as much about complying with laws concerning disabled workers or laws insuring that workers will not become disabled on the job.  The loser in developing countries is society as a whole: workers receive lower wages than they should, companies institute few protections and benefits in the workplace, and the environment becomes increasingly polluted.

Opponents argue that just as the U.S. had to go through its messy industrial revolution with lower wages and poor sanitation, so do developing countries today.  In the long run these developing countries will more closely mirror the U.S. and then everyone will be better off.  Yet, developing countries do not have to go through the messy process the U.S. went through precisely because of where we are at today.

We are in a free-trading, globalizing world, where economic models are changing.  The U.S. is pushing to liberalize trade between developing countries and us, and every country wants access to our market because of its vast size and the propensity of American consumers to spend.  The U.S. could use this negotiating muscle, its economic might and ideological influence known as soft-power, to create better trade agreements that would improve working and living conditions in developing countries.  Our government could create stipulations that if a country wants to sell its products in the best market in the world, then it has to pay its workers a fair wage, prohibit companies from desecrating the environment, and hold firms accountable to governmental regulations and workplace safety concerns. 

The catch is that this leverage only works when there is no agreement signed.  Once a free-trade deal passes, it is close to impossible to reverse course and pursue a more humane labor and environmental policy.  The U.S. is at a momentous point where it is currently negotiating scores of trade agreements around the world with countries who would do almost anything to sell goods to American consumers.  These stipulations would be good for American jobs as well since companies would not outsource so many jobs so soon as operating expenses, while still lower than at home, would not be at the bargain basement levels currently in existence.  Yet, corporate influence is too much for government leaders.

The problem is that the balance between CEOs and wage earners is completely off-kilter and the reason is the current state of globalization.  Multi-national companies allow firms to compete in different markets, seek the cheapest place to do business, and constantly move if governments or unions restrict their activity too much.  These companies can traverse the globe, find what suits them best, and leave the rest behind.  Conversely, unions are stuck in one state, one region, or one country.  They cannot compete with multi-national corporations precisely because unions are not multi-national.  In our new globalized world, corporations have all the clout and advantages while unions are left behind.  The results for workers have been disastrous.

Big companies are doing great.  In the current economic climate, thanks to Bush’s tax cuts, reduction in business oversight by the government, and freer trade, corporate profits as a share of GDP are as high as they have been in 40 years.  Remember, the economy grew at a healthy 3.4% last quarter, the ninth straight quarter that growth has been above 3%, representing the longest streak since the mid-1980s.  Income and wealth for those at the top keep growing, but what about for the rest of us?

The same day that the Commerce Department released its report on GDP growth, the Labor Department reported that wages and salaries increased 2.4% over the previous 12 months.  At first glance, this may seem like good news, but inflation rose over 3% during that same period, so real wage growth was actually negative.  It used to be that when the economy grew, everyone benefited somewhat; now, a few people are becoming extremely wealthy and the rest of us are getting poorer in real terms.  To be fair, a good part of the anemic wage growth has to do with increasing health care costs, a separate problem altogether.  Still, a consistent factor for poor wage growth has to do with the way the world is globalizing.  Trans-national companies in a pro-CEO climate without trans-national labor unions put enormous downward pressure on wages and upward pressure on profits.

50 years ago, usually only one parent in a family was in the workforce, and that was enough for parent’s to support an entire family, send their kids to college, and have enough leisure time to enjoy life.  Today’s world is starkly different.  College tuition is through the roof, both parents work, and there are fewer and fewer hours to just appreciate life.  Many families are still not making ends meet and with inflation going up faster than wages, the future does not look too bright. 

Numerous studies published anywhere from think-tanks to mainstream journalism such as The New York Times and The Economist have cited the growing inequality gap as cause for concern.  The current political structure where money talks only reinforces the inequalities in the system.  There is nothing wrong with free trade –in fact, it should be looked at positively –but the way it has been done has enriched those already rich while squeezing the middle class.  Technological innovations have created the illusion of rising standards-of-living, when in reality technology is merely propping up lower wages.  While it is laudable that globalization has helped hold down prices, the externalities caused by freer trade, from environmental degradation to workplace hazards, are not worth the cost.  Through soft-power and trade-agreement leverage, America can shift the way we are globalizing to a more utilitarian structure, helping the most people and leaving the fewest behind.

From a superficial level, U.S. economic and trade policy appears to be working very well, but when one looks at exactly how these abstract tasks are carried out, an ugly pattern soon emerges.  It is not too late to shift course.  The U.S. still has plenty of leverage left to use, and as the CAFTA vote illustrates, many Representatives have alternative views on our current economic model.  It is time to shift the media focus from GDP growth to wage growth, from free trade to fair trade, to insure that the next 50 years sees the pendulum swing back to a philosophy where equality of opportunity actually meant something.